It's time to give structured products a chance

Guest blogger Ian Lowes of Lowes Financial Management looks at why structured products - an investment with a less-than-brilliant reputation - is starting to get some love.

Structured products are investments whose performance is linked to the performance of something else over a period of years. Generally this 'something else' is a stock market index, such as the FTSE 100 or a basket of individual shares.

The number of structured product investments on the market has grown slowly but surely in recent years. The number available through IFAs rose from 302 in 2008 to 468 in 2011. And they attract some serious cash -in 2011, the total figure invested was £9.1 billion, according to Structuredretailproducts.com.

Why structured products are becoming more appealing
But it's not just the numbers that have increased. So too has the diversity of these products in terms of their characteristics. They are now much more attractive to the specific risk profiles and requirements of far more people.

Now, if the index or stocks to which the plan is liked to do well within a specified timeframe, often six years, the investor will get all their money back with a decent gain on top (the exact 'upside' will clearly reflect the risk profile of the investment).

If the index or stocks the product is linked to don't perform well, the investor might just get back their initial capital and nothing else, or sometimes less than they invested.

In extreme cases, such as the bank going bust, investors could lose all their capital.

An example
Probably the best way to explain these investments is to look at one in more detail. I've chosen one that I like quite a lot: the Legal & General Early Bonus Plan 8.

Early Bonus Plan 8
This product can run for up to six years, although it could mature after one year. Breaking it down into its key elements, it works like this:

if, on any 'annual observation date' (anniversary), the FTSE 100 closes at or above the level it was at when the plan started, investors will get all their capital back - whatever happens thereafter. In addition to this they will get a 10% return on their investment for every year (up to a maximum of six years) that the investment was in force. So basically investors could get their investment back after one year with a 10% gain.

if the FTSE doesn't close at or above its starting level on any annual observation date, then closes up to 50% lower at the end of the six years, then the investor will receive only their capital back.

if the FTSE 100 doesn't close at or above its starting level on any of the anniversaries and is more than 50% lower at the end of the plan then capital will be reduced in line with the fall in the index. So if the FTSE is below the initial level every year and 57% below its starting level at the end of the plan then the initial capital outlay would be reduced by 57%.

The other risk to bear in mind is that if Santander UK, the bank that ultimately backs the investment, defaults, then the return of capital will be subject to insolvency proceedings. Potentially, this could mean a total loss of capital.

Risk versus reward
Clearly whether or not someone should invest in Early Bonus Plan 8 will depend on their circumstances and attitude to risk. However, many people who are prepared to consider medium-term stockmarket investments will generally expect this investment to produce a gain.

After all, for them not to achieve a gain and return of their capital the FTSE will have to be lower than its level recorded at the start of the plan on all of the annual observation dates and more than 50% lower at the end.

While not impossible, I expect it would take something seriously extreme to happen to the global economy for such dire and unprecedented stockmarket performance to occur. And, of course, any money invested in the stockmarket would be in jeopardy, especially money in tracker funds, which are often an alternative to structured products.

Look at it another way: let's say the FTSE 100 is down 49% in six years' time and was below its starting level every year. If you were in a tracker, you would have lost a significant portion of your investment. With this plan, despite that extreme fall, you'd get all your money back.

Portfolio planning
Structured products will rarely make up an entire portfolio, but instead be part of a diversified range of investments reflecting a person's risk profile.

By no means am I a blind apologist of these products. Some I do not like at all and have warned people to avoid. But I do think structured products generally are an area that investors should look into in more detail.

It may be a cynical note to end on, but one reason more IFAs might not recommend these products is because they don't pay as much commission as unit trusts.

But with commission set to disappear as of next year and more people buying investments online, I expect them to become more widely used and, dare I say, appreciated.